The Man and the Thinking Behind the Minimum Wage Hike

President Obama is pushing a controversial hike in the minimum wage. It is surely no coincidence that his chief economic advisor is Alan Krueger, an economist who became famous in the 1990s for research supporting minimum wage hikes. But don’t higher wages mean fewer jobs? Krueger explains at length why they don’t.

Alan Krueger shakes hands with President Barack Obama after announcing his nomination in August 2011 as chairman of White House Council of Economic Advisers. Krueger was confirmed by the Senate on Nov. 3, 2011. Photo by Andrew Harrer/Bloomberg via Getty Images.

During his State of the Union address Tuesday evening, President Obama challenged Congress to do what it could to help the middle class. Of the many economic issues in his address, raising the minimum wage to $9 an hour and tying it to the cost of living is nothing short of controversial. It is surely no coincidence that the chairman of the president’s Council of Economic Advisors is Alan Krueger, an economist who became famous in the 1990s for research supporting minimum wage hikes.

Back in 1996, not long after “Myth and Measurement,” his then ground-breaking and controversial book with David Card on the minimum wage first came out, I interviewed Alan Krueger at length about the minimum wage, which so many economists at the time opposed because, as critics argued after the State of the Union address, raising wages supposedly reduces the incentive to hire workers. By contrast, Krueger and Card found, a study of workers in New Jersey and neighboring Pennsylvania showed no decrease in fast food employment when the minimum wage was raised.

Krueger is now the chair of the President’s Council of Economic Advisors. He is a key – if not the key – presidential economic advisor. So if you want to understand the President’s economic reasoning in pushing for a minimum wage hike, there may be no better place to start than with Krueger’s original reasoning.

In the years since, he has become one of the country’s most respected economists. But his support for hiking the minimum wage has remained consistent, as has his reasoning for “indexing” the minimum wage to inflation, something he makes quite clear near the end of the interview I did with him in, excerpted at length for the first time below.

Why Would People Think Employment Goes Down If the Minimum Wage Increases?

Paul Solman: Could you explain to a completely unsophisticated audience, in non-economic terms, why the conventional wisdom was that employment would go down if the minimum wage was boosted?

Alan Krueger: Well, increasing the minimum wage increases the cost of labor. And unless the productivity of workers increases at the same time, then it won’t be as profitable for employers to employ as many employees with the higher minimum wage than was the case previously.

So the conventional wisdom is that employers would try to minimize their losses by reducing the workers. Either replacing equipment for the workers or just cutting back on the amount of output that they produced.

Paul Solman: But since all employers would have to abide by the minimum wage, any given employer would lose versus the competition, so why wouldn’t everybody simply raise their prices?

Alan Krueger: Well, I think in large part, that’s what happens.

What Card and I discovered in our research is that the prices of fast food increased by about the amount that would be necessary to compensate the employers for the higher cost of labor.

One issue that arises is that when employers contemplate an increase in the minimum wage, they don’t take account of the fact that their competitors will also face a higher minimum wage, and therefore they won’t be at a disadvantage compared to their competitors. Instead, prices will rise and that will help to offset their higher costs and soften the blow of the minimum wage increase.

That’s an important factor that takes place in the economy, but there are some other factors too which help to cushion the conventional thought that a higher minimum wage reducing employment.

Paul Solman: That would suggest that for people who hire minimum wage employees, their customers are not as responsive to price changes as they might think.

Alan Krueger: It’s a relevant point. You might think if prices increase, then they’re going to lose customers. People might not go out to restaurants, they might do it at home. And if prices went up quite a bit, that might be the case.

But it turns out, you don’t have to raise prices that much to offset the higher costs of a minimum wage increase. What we found was that about a 3 percent increase in the price of fast food was enough to compensate the employers for the higher cost of labor as a result of the minimum wage increase.

A 3 percent increase in prices is hardly noticeable to most customers. So that’s one reason why you don’t see much of an effect on the product demand side: There isn’t a reduction in people going to the fast food restaurants when the minimum wage increases.

And I would also add, that customers accept it. If they’re told, “Look, prices went up because the minimum wage increased. It’s not that we’re being greedy; It’s that we’re required to pay higher wages,” I think that they are willing to accept that kind of a price increase. That’s one factor that the higher prices helps to offset the cost of the minimum wage.

What Are Some Benefits for Employers When Minimum Wage is Raised?

Alan Krueger: Another factor that helps offset the cost of the minimum wage is that it helps employers sometimes find inefficiencies.

For example, if workers are paid more, they have lower turnover. Turnover is costly for employers, especially when they have to train new workers coming in and when they have to search for workers. So, the higher wages help to increase productivity. And the employers might also discover some ways of saving waste that they had before when the minimum wage increases.

In addition, some employers, at the current minimum wage, can’t hire all the employees that they want. They’re reluctant to raise their wages because if they raise the wage for new workers, they’re going to have to raise it for everybody else. But as a result (because they don’t raise wages), they struggle with very high turnover, with vacancies.

Now the government comes along and says, “you have to raise the minimum wage.” Well, this helps them to fill some of their vacancies. Now some employers might find that they no longer want to fill their vacancies when the minimum wage goes up, that’s a conventional effect.

But others may find that they were reluctant to raise the wages before, but now the government required them to raise it, and they still want to fill those vacancies. I think that those effects all kind of cancel out.

When we have a moderate increase in the minimum wage, then the net effect on employment is pretty much a wash. Some employers see an increase in employment because they fill their vacancies, because they can reduce some inefficiencies and others will have a conventional effect of a reduction. The net effect is basically no change in overall employment.

Does the Government Help or Hurt Businesses by Getting Involved?

Paul Solman: Say I’m the employer. How is the government helping me with the problem here?

Alan Krueger: Well, the government is not increasing your profit, right? Because you always could have increased the wage yourself. So it’s profitable for you to keep the wage low, perhaps as low as the minimum wage and getting by with high turnover and vacancies and hoping that you’ll find someone who’s coming in, who’s willing to work at the current minimum wage.

So on your own, you don’t want to raise the wage. But the government steps in and says, “You have to raise the minimum wage now.” Then you might rethink your strategy. And you might say, well, now I can fill some of these vacancies, whereas before, I was making a higher profit, but I was struggling to get enough employees.

When the government requires me to raise the wage, I have to raise it for everybody, so I don’t have this equity issue about paying more for the new workers, compared to the workers who I already have, because I’m required to pay more to everyone.

How High Can You Raise the Minimum Wage Before It Discourages Employment?

Paul Solman: How high can you jack up the minimum wage before you start discouraging employment? Why shouldn’t Wal-Mart — why shouldn’t all big box stores — be required to provide full healthcare benefits, for example? How far can you push this?

Alan Krueger: That’s a really good question. And David Card and I, in our book, “Myth and Measurement: The New Economics of the Minimum Wage,” tried to look very hard for the tipping point. I think that there is a level at which the conventional effects dominate — when the minimum wage goes too high and employers cut back on employment.

Sometimes people mock us. They’ll say, “why not raise the minimum wage to $20 an hour or $30 an hour?” Which is a little bit like saying, “it’s cold in this room, why don’t we raise the temperature? Why don’t we keep raising it to 120 degrees, 130 degrees?”

There’s some tipping point. And in the U.S., in the experience that we’ve been able to look at, I don’t think we’ve gone beyond that tipping point. So the minimum wages that have been proposed at the state level or at the national level, I think have been within that range.

What’s been proposed for the US at the state level and the federal level I don’t think typically has gone beyond that. At least we haven’t been able to find evidence on that.

Indexing the Minimum Wage

Alan Krueger: So how did we get into this situation where the value of the minimum wage was allowed to erode so much due to inflation over time? And I think one of the issues is that, in Congress and in most states, the legislature has to revisit the minimum wage periodically for it to go up.

Both sides might have an interest in having a battle over it. You can imagine that Republicans think it’s in their interest because they get more support from small businesses if they have a fight over the minimum wage every few years. And the Democrats might think it’s in their interest because they get support from unions and from employee groups by having this fight.

So the politicians might have an interest in having a fight other this issue every two, three years and depending upon who controls Congress, or who controls the White House that affects whether the minimum wage goes up or not when those rights arise.

An alternative would be to index the minimum wage. To index the value of the minimum wage so it increases with the wages of other workers or that it increases with overall inflation.

I had proposed previously that if the minimum wage is to be indexed, it might make sense to index it to the wage rate of a worker that’s at the 25th percentile of the wage distribution. So the bottom quarter of the workforce, rather than the average wage or overall inflation because that way, forces that are affecting the shape of the overall wage distribution are going to affect the pace at which the minimum wage increases and you are less likely to have a situation where the minimum wage kind of gets out of line with, with market forces.

That’s a complicated idea because you have to figure out what the 25th percentile of the wage distribution actually is and explain that to people.

It’s probably easier to just say, the inflation rate is three percent this year, we’ll raise the minimum wage by three percent, if it’s two percent, we’ll raise it by two percent. But I think of these as kind of interesting alternatives so that Congress can work on other issues and not have this regular fight over what to do with the minimum wage.

But maybe that’s too complicated. You don’t want to outsmart yourself in doing this, but I think an issue that should get serious consideration is, indexing the minimum wage so that Congress could worry about other issues, you know, rather than putting in so much energy and, and having such a partisan fight every few years over the value of the minimum wage.

This entry is cross-posted on the Rundown — NewsHour’s blog of news and insight.

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